As a rule, I'm not in favor of share buybacks. However, rules are made to be broken, and Kearny Financial Corporation (NASDAQ:KRNY) is one such exception.
Background
In May of 2015 Kearny announced that it had completed its conversion from a:
mutual holding company to the stock holding company form of organization. As a result of the closing of the conversion and stock offering, the Company is now the holding company for Kearny Bank. Kearny Financial Corp. ("Kearny-Federal") and Kearny MHC, the Bank's former mutual holding company, have ceased to exist.
... Approximately 93,529,444 shares of Company common stock will be outstanding after the completion of the offering and the exchange, before taking into account adjustments for fractional shares.
Why bring something up now that occurred more than six years ago? Mostly because there have been some recent announcements about Kearny share buybacks. It's a practice I'm generally not in favor of, preferring that companies use excess cash to increase their dividends, pay a special dividend or make accretive acquisitions. All too often the share counts don't fall because new shares are issued as part of executive, board and employee compensation or benefit packages, or for acquisitions. And, it's not just that the share counts don't decline as much as anticipated.
Buybacks often occur when things are going well for the companies and they are flush with cash. When things are going well, share prices tend to be high. How many of you reading this article decide to invest in a company when the prices of the shares are high as opposed to the mantra "Buy low, sell high"?
Years ago I came across an interesting study by Credit Suisse titled Stock Buybacks: Adding Value or Destroying Value? The report confirmed some of my negative views to share buybacks, and began:
Before jumping for joy the next time a company announces a share buyback ask yourself a simple question: Is the company paying less than the intrinsic value of the stock (i.e., is it making a good investment)? If it is, then jump for joy (assuming the company doesn't have better investment opportunities) as the buyback will add value for the remaining shareholders (it's a transfer of wealth from those that sold to those that continue to hold). On the other hand, if the company is paying more than intrinsic value you might want to ease up on the jumping (even if its accretive to earnings) as the buyback will destroy value for the remaining shareholders (in this case wealth is transferred from those that hold to those that have sold).
There is a lot of detail in the study, including the methodology, but the bottom line was what occurred with the S&P 500 companies during the study period. The study showed the following between 2004 and 2011:
There are 306 companies or 61% showing a positive return, 154 companies or 31% with a negative return and 40 companies that had no buybacks over the past eight years. But if you were to benchmark against a cost of equity of let's say 7%, we find only 180 companies or 36% that beat the benchmark. As a result it looks like most of the buybacks for the S&P 500 over the past eight years have not yet added much value for the remaining shareholders.
Putting Things in Perspective
The event that prompted this article was the announcement on September 22nd that:
Kearny Financial Corp. Announces Authorization of New 10% Stock Repurchase Plan
... Kearny Financial Corp. (the "Company"), the holding company for Kearny Bank, announced today that the Board of Directors has authorized a new stock repurchase plan to acquire up to 7,602,021 shares, or approximately 10% of the Company's outstanding common stock.
One of the things that I have found a bit unusual with Kearny was the specific number of shares to be acquired rather an indefinite dollar amount expressed as "Up to X million (or billion) dollars". This exact number of shares practice has been maintained by Kearny through each announcement following the conversion. And, each of the announced buybacks resulted in the exact amount actually being purchased. So, how should investors react to Kearny's buyback(s)? Considering my generally negative view of share buybacks, I decided to track the share count since that May of 2015 conversion, along with the various share buybacks and acquisitions using stock since that date. The first such buyback was announced on May 20, 2016, stating that the Board had...
... authorized a stock repurchase plan to acquire up to 9,352,809 shares or 10% of the Company's currently outstanding common stock...
Before the result of that first buyback was disclosed, on May 24, 2017 Kearny announced that the Board had authorized...
...a second stock repurchase plan to acquire up to 8,559,084 shares or 10% of the Company's currently outstanding common stock. ...
Kearny would subsequently report that it...
...ultimately repurchased 9,352,809 shares [Note: This was the exact amount specified in the press release announcing the buyback] under that plan, at a total cost of $130.6 million and an average cost of $13.96 per share.
More to the point, as of June 30, 2017, the end of the Kearny fiscal year, the company had 84,350,848 shares outstanding, down by 9,178,596 shares from the 93,529,444 shares outstanding at the time of the conversion in 2015. Not exactly the 10% drop that would have been expected if no new shares had been issued, but fairly close. Before the second share repurchase had been completed, Kearny would acquire Clifton Savings Bank in an all-stock transaction where each share of Clifton would be converted to 1.191 shares of Kearny common stock. The Clifton transaction closed in April of 2018, and on May 2, 2018 Kearny filings showed that the share count had climbed up to 102,385,573, significantly above the initial count.
Jump Ahead to September 2021
While I could go through each of the relevant events, showing how the number of shares outstanding rose (with acquisitions and employee compensation programs), and fell (with buybacks), I decided to take a shortcut. Since we know that the September 22nd announcement specified that Kearny planned "to acquire up to 7,602,021 shares, or approximately 10% of the Company's outstanding common stock", we know that the number of shares outstanding at the time of the press release was ~76,020,210, a decline of nearly 19% from the 93,529,444 issued at the time of conversion.
And, if everything goes as planned, the shares outstanding will be further reduced to:
76,020,210 - 7,602,021 = ~68,418,189 shares outstanding.
That would be a net reduction of 25,111,355 shares, or 27% of the amount issued at the time of the conversion.
So, have the share buybacks benefited Kearny's shareholders? Not that one would notice. Friday's closing share price was $12.75, 19% above the $10.72 closing price following the conversion. However, considering the fact that the shares outstanding have declined by (coincidentally) 19%, and that the company had made two acquisitions, I would have expected each share to be more valuable.
Disclosures
I often include a disclosure statement in the articles that I write. I am almost always long the equity covered, and make every I attempt to write articles that are not biased by my long positions. In the case of Kearny, I still hold a very small position, just under 1% of our individual equity holdings, and will likely continue to add to the position. We are also currently reinvesting the dividends.
The Dividend
Kearny's dividend was one of the reasons we initially purchased the stock a year ago despite its erratic history. Kearny began paying a $0.05 quarterly dividend in 2005, and maintained it through the financial crisis and Great Recession. However, in 2012 it was cut to zero and wasn't restored until Q3 of 2015 when it was resumed at $0.02. It remained at that level through the end of 2016. It was then increased to $0.03 for five quarters, with an additional special dividend payment of $0.12 in October of 2017. In the second quarter of 2018, it was increased to $0.04 for two quarters, followed by another special dividend in Q3 - this time for $0.16 - before finishing the year with a quarterly payment dividend payment of $0.05.
While there have been no more special dividends in the past few years, the regular quarterly dividend was increased to $0.06 for the first three quarters of 2019, before another increase to $0.07. Last year there were four payments of $0.08 followed by three payments of $0.09, $0.10 $0.10. Based on the erratic increases in the dividend, it is difficult to forecast how soon, or by how much, the dividend will again be increased.
The most recent dividend was paid September 15th, and the yield, based on Friday's closing price, is 3.14%. A yield barely above 3% isn't likely to be enough to attract a lot of dividend investors, but that dividend does seem well covered and a case could be made that the payout should currently be higher. And, when one factors in fewer shares outstanding following the buyback...
Looking Forward
I expect the current buyback to be completed, and that the shares outstanding will continue to decline. With significantly fewer shares outstanding, the simple math indicates there should be ample room to again increase the dividend. Seeking Alpha requires authors to give a stock one of five ratings Very Bearish, Bearish, Neutral, Bullish, or Very Bullish. Unfortunately, to the best of my knowledge, Seeking Alpha hasn't tied any specific metrics to these ratings.
Three months ago, when I wrote a prior article, the price was $9.285 (although the price at publication was $9.54) and I rated Kearny Very Bullish. That rating was based not only on the rising dividend, but also on my view that the potential appreciation over the next year would exceed 20%. With the current price of $12.75, the gains have blown through my optimistic expectations, and I am lowering the current rating.
Based on the completion of Kearny's most recent acquisition and the expectation that there is plenty of room to increase the dividend, I am looking forward to another dividend increase or two over the next year and another double-digit percentage move higher in the share price. And, while I can see the share price reaching $14, I don't think it's reasonable to expect another 20% move to the upside (to $15.30/share), my hurdle rate to warrant a Very Bullish rating.
